3 of the Best ETFs to Buy and Hold if a Recession Is Coming

Source The Motley Fool

Key Points

  • VHT is a diversified play on the non-cyclical healthcare sector.

  • BND will benefit from interest rate cuts in a recession.

  • VOO could still remain the best long-term play for patient investors.

  • 10 stocks we like better than S&P 500 Index ›

The U.S. has experienced ten official recessions since the S&P 500's (SNPINDEX: ^GSPC) inception in 1957. Therefore, it's only a matter of time before the next recession occurs.

However, the worst thing you can do is to panic and sell your stocks during those downturns. The S&P 500 has still delivered a total annual return of 10% since its inception, despite steep double-digit drawdowns during bear markets. Its top stocks delivered even bigger gains.

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So if you don't want to lose sleep over individual stocks, it makes more sense to stick with exchange-traded funds (ETFs) that hold diversified baskets of stocks. Let's take a look at three of those resilient ETFs that you should buy and hold if you expect a market downturn.

An illustration fo a bear clashing with a bull.

Image source: Getty Images.

Vanguard Healthcare ETF (VHT)

Healthcare is a non-cyclical sector that is well-insulated from macro headwinds. The demand for pharmaceutical drugs, medical treatments, and insurance doesn't dissipate during a recession.

Vanguard's Healthcare ETF (NYSEMKT: VHT), which charges a low expense ratio of 0.09%, is one of the easiest ways to gain instant exposure to the sector's top stocks. It passively tracks the MSCI U.S. Investable Market 25/50 Healthcare Index, which includes all top U.S. healthcare companies, balanced by the "25/50" rule: no single stock can exceed 25% of its total assets, and the combined weight of all stocks exceeding 5% of its portfolio cannot exceed 50%.

Sticking with the 25/50 rule keeps the ETF diversified and prevents megacap stocks from hijacking its performance. It also allows the fund to remain compliant with the IRS's rules for Regulated Investment Companies (RICs), which are allowed to pass their capital gains and dividends directly to investors without paying corporate taxes.

VHT holds 416 stocks, and its top holdings include Eli Lilly (12.8%), Johnson & Johnson (8.7%), AbbVie (6.3%), Merck (5%), and UnitedHealth Group (4.9%). It only pays a 30-day SEC yield of 1.2%, but it's delivered an impressive total return of 757% since its inception in Jan. 2004.

Vanguard's Total Bond Market ETF (BND)

When the economy grows too quickly, the market's demand for products and services outstrips its supply and triggers inflation. To rein in inflation, the Federal Reserve usually raises interest rates to temporarily throttle economic growth.

But when a recession occurs, the economy shrinks, prompting the Fed to cut rates to spur more lending and spending. When interest rates decline, the prices of older bonds rise because they have higher-yielding coupons than newly issued bonds.

So if you're expecting a recession followed by rate cuts, it makes sense to invest in Vanguard's Total Bond Market ETF (NASDAQ: BND) -- which holds 11,421 bonds with an average yield to maturity of 5%. Its top holdings include U.S. government bonds (68.9%), BBB-rated bonds (12.3%), and A-rated (12.1%) bonds. It charges a low expense ratio of 0.03%.

With a 30-day SEC yield of 5.1%, BND should remain a popular haven for income-oriented investors in a recession. It's only delivered a total return of 73% since its inception in April 2007, but it's designed to be a stable investment rather than a market-beating one.

Vanguard's S&P 500 ETF (VOO)

It might seem silly to invest in the S&P 500 if you expect a recession, but it's historically been the smartest choice for investors who can stomach the near-term volatility. Since its inception in Sept. 2010, Vanguard's S&P 500 ETF (NYSEMKT: VOO) -- which passively tracks the S&P 500 with a low expense ratio of 0.03% -- has delivered a total return of 827%.

VOO provides investors with instant exposure to the top U.S. stocks -- including Nvidia, Apple, Microsoft, Amazon, and Alphabet -- and is rebalanced quarterly to include only the country's 500 largest companies. Even though VOO might experience more pain than VHT and BND in a market crash, it should bounce back as long as the biggest companies in America continue to grow their revenues and profits.

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Leo Sun has positions in AbbVie, Amazon, and Apple. The Motley Fool has positions in and recommends AbbVie, Alphabet, Amazon, Apple, Eli Lilly, Merck, Microsoft, Nvidia, Vanguard S&P 500 ETF, and Vanguard Total Bond Market ETF. The Motley Fool recommends Johnson & Johnson and UnitedHealth Group. The Motley Fool has a disclosure policy.

Disclaimer: For information purposes only. Past performance is not indicative of future results.
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